Morningstar DBRS Confirms Kingdom of Sweden at AAA, Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Kingdom of Sweden's (Sweden) Long-Term Foreign and Local Currency - Issuer Ratings at AAA. At the same time, Morningstar DBRS confirmed Sweden's Short-Term Foreign and Local Currency - Issuer Ratings at R-1 (high). The trend on all credit ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
The confirmation of the Stable trend reflects the view that risks to the credit ratings are limited. Sweden's strong public finances and solid macroeconomic fundamentals, position the country well to withstand the near-term weak economic environment, which has been exacerbated by tight financing conditions, a fall in private consumption, and the slump in construction activity. After the modest recession in 2023, GDP growth is set to recover, although slowly. Sweden's healthy public finances are not expected to be significantly altered by subdued economic performance over the medium term. Morningstar DBRS foresees the fiscal deficit deteriorating this year and improving only gradually, but the parliamentary elections in 2026 might delay the return to fiscal surplus. Fiscal policy is expected to be more expansionary in the near term. Nevertheless, this should not affect significantly the public debt ratio, which is expected to remain slightly above 30% of GDP in the coming years. However, financial stability risks, as a result of high interest rates in the context of high household debt and elevated refinancing risks for Commercial Real Estate (CRE) companies, remain relevant. Although the labour market is cooling, it will continue to remain resilient, mitigating any impact of the worsening in household debt affordability. Moreover, balance sheet improvements are taking place in a large share of property companies, a sector that should benefit from less tight financing conditions as inflation retreats.

Sweden's AAA credit ratings are underpinned by its strong public finances, healthy external accounts, and a robust institutional environment. Moreover, while near-term growth rates will likely be subdued, Sweden's high investment and employment rates, and its skilled labour force will continue to underpin its solid economic performance in the coming years. On the other hand, as a small and open economy, with strong commercial and financial links with the rest of the world, the country remains exposed to potential shifts in external demand and/or global financial conditions. In addition, managing the risks stemming from the combination of high household leverage, banks' large exposure to the property market, and elevated housing prices remain a challenge for Sweden. Nevertheless, wealthy households in aggregate and the expected modest deterioration in the labour market are reassuring. Moreover, the challenges stemming from the CRE sector are likely to put pressure on credit quality but Swedish banks are well equipped to absorb the expected rise in nonperforming loans.

CREDIT RATING DRIVERS
Morningstar DBRS could downgrade the credit ratings if Sweden's public debt ratio trajectory experiences a material deterioration, although this is viewed as unlikely. A materially higher public debt ratio could result from a severe worsening of the medium-term growth outlook, a lasting and material weakening of fiscal policy, and a substantial materialisation of contingent liabilities. A significant shock stemming from the financial sector could also put negative pressure on the credit ratings.

CREDIT RATING RATIONALE

Sweden's Subdued Economic Performance Will not Alter its Position of Strength

Sweden's credit fundamentals are underpinned by its high GDP per capita level, historical sound economic performance, and limited output volatility despite its small size. The European Commission (EC) projects Sweden's GDP per capita at around 135.5% of the EU-27 average in 2024, which reflects a competitive and advanced economy with a productive labour force and one of the highest employment rates in the EU-27. Output, despite the recent weak performance, remains around 5.0% higher than the pre-pandemic level.

After a rapid post-pandemic economic recovery, Sweden's economic performance has been weak since Q4 2022, reflecting high inflation and elevated interest rates weighing on consumption and on investment, particularly in dwellings. The large share of mortgages with a short fixation period, in the context of a high level of debt, made monetary tightening transmission rapid. This has worsened households' debt affordability and, along with the negative wealth effect, due to declining house prices, translated into a contraction in private sector consumption in 2023. The improvement in the net trade balance did not prevent GDP from contracting by 0.2% in 2023, but economic activity has since started recovering. A better-than-expected start of the year, with GDP expanding by 0.7% quarter-on-quarter, led the government to raise its GDP projections for 2024 in June. Economic activity is now expected to expand by 1.4% compared with 0.7% estimated in April. Looking ahead, Morningstar DBRS projects GDP growth to continue to improve as monetary policy will be less of a drag, reflecting a continuation in the easing interest rate cycle thanks to the retreat in inflation. GDP will likely expand by 2.4% and 3.1% in 2025 and in 2026, respectively. However, a more prolonged period of high interest rates could delay the recovery, intensifying the deterioration in the labour market. The unemployment rate is already expected to peak at 8.4% in 2024 from 7.7% in 2023. On the other hand, Morningstar DBRS expects Sweden's fundamentals to remain strong as current cyclical economic weakness will likely not alter its position of strength.

A Solid Fiscal Framework and a Low Public Debt Ratio Underpin Sweden's Creditworthiness; Deficit Set to Deteriorate

Sweden's very strong fiscal performance, underpinned by its fiscal framework, and its low public debt level constitute important credit strengths. Pre-pandemic, the budget balance was typically in surplus and the impact of the pandemic on public finances was relatively moderate. After a surplus of 1.2% of GDP in 2022, the budget balance shifted to a modest deficit of 0.6% of GDP last year, and is anticipated to widen to 1.7% of GDP in 2024, before gradually turning to a surplus in 2026. This would reflect the build-up in defence spending, the weak economic activity, higher social benefits, and lower tax on petrol and diesel. Moreover, the government is expected to inject capital into the country's central bank, the Sveriege Riksbank (Riksbank), amounting to SEK 25 billion, or 0.4% of GDP. Nevertheless, this capital transfer should not affect the structural balance that the government projects to be in slight deficit of 0.2% of GDP in 2024 before improving to a surplus of 0.7% in 2026. As elections approach, Morningstar DBRS takes the view that the improvement in public finances might be slower than expected but the country's fiscal position will remain solid in the medium term. While the fiscal stance is expected to be slightly more expansionary in the near term it will continue to be anchored around the government`s surplus target of 0.33% of GDP over an economic cycle.

Sweden's low public debt ratio, among the lowest in the EU-27, provides the country with ample room to implement counter-cyclical fiscal policy if needed. The modest increase in the debt ratio to 40.2% of GDP in 2020 from 35.6% of GDP in 2019, due to the impact of the pandemic, has been reversed rapidly. Stronger economic and fiscal outturns led the public debt ratio to drop to 31.2% of GDP by the end of 2023. Sound nominal growth and a modest increase in the interest bill will contribute to keeping the public debt ratio slightly above 30% of GDP in coming years. In the absence of significant shocks or material expansionary fiscal measures, the public debt ratio is expected to remain consistent with the debt anchor (35% of GDP +/-5 percentage points) in the medium term.

The materialisation of contingent liabilities, potentially stemming from Sweden's large public sector exposure to financial sector-related entities, or the extension of state guarantees, could lead to a higher but still manageable debt ratio. Moreover, Morningstar DBRS also takes the view that the associated risks to Sweden's relatively short average debt maturity and high share of foreign currency-denominated debt are contained. This relates to Sweden`s comparatively low level of debt, steady demand for Swedish government bonds, and the use of derivatives to hedge currency risk. Despite the rapid increase in Sweden's government bond yields, the country is expected to continue to benefit from favourable financing costs. The relatively high share of inflation-index linked bonds should weigh less on interest costs as inflation stabilises towards the target going forward.

Risks to Financial Stability are Relevant But Manageable; Households Balance Sheets are Still Resilient and Banking Sector is in Good Shape

Since Q3 2023, households' debt affordability has worsened reflecting high inflation and monetary policy tightening but this is mitigated by the resilient employment rate and high net wealth of households in aggregate. Morningstar DBRS takes the view that the easing in inflation along with lower interest rates should relieve households' financial position. Growth of the consumer price index with a fixed interest rate (CPIF) declined to 1.3% in June 2024, from the peak of 10.2% in December 2022 and it is expected to continue to fall, albeit slowly. With inflation declining, the Riksbank will likely continue to gradually ease its monetary policy, after the first reduction in the policy rate of 25 basis points to 3.75% in May this year. Although financing conditions are likely to improve over time, Sweden's households will continue to face one of the highest interest payments as a share of disposable income in the EU.

After increasing by around 29% between March 2020 and mid-2022, housing prices dropped by around 19% as of July 2023 and since then have partially recovered by about 7%. The house price correction and credit growth contraction, due to monetary tightening, have improved imbalances in the financial system, with household debt as a share of disposable income falling to 189% in Q1 2024 from the peak of 205% in March 2022. However, risks to financial stability remain relevant, in light of still overvalued property prices, high household debt and vulnerability in the CRE, to which the banking sector is highly exposed. These factors weigh on the Monetary Policy and Financial Stability building block. Property prices are recovering but remain elevated reflecting decades of growth rates higher than those of GDP. A prolonged period of high interest rates if accompanied by a new and sharp fall in property valuations could be a further drag on consumption. However, Morningstar DBRS views households' balance sheets in good shape in aggregate and good margins exist to continue servicing debts under stressed conditions. Moreover, the employment rate is still favourable at 75.8% as of Q1 2024 and the deterioration in the labour market in the coming months is projected to remain contained. Given also supply shortages with the housing market recovering and financing conditions easing, Morningstar DBRS expects imbalances in the Swedish housing market to rise again, although slowly (https://dbrs.morningstar.com/research/428135/sweden-housing-vulnerabilities-likely-to-rise-again-but-slowly).

The commercial property market also remains a source of risk, given banks' large exposures. A high share of property developers face elevated refinancing risk in the context of high interest rates. Although some property companies have been able to improve their balance sheets, there is still a basket of companies that is heavily indebted and exposed to material refinancing risks. Some developers have also replaced market borrowing with bank lending, while others have sold part of their properties and reduced new construction projects. Subdued domestic demand is translating into an increase in bankruptcy rates and consumer credit banks appear more vulnerable with growing loan losses. These banks, although representing a small share of total assets in the banking system, might pose some systemic risks, according to the Riksbank. However, the overall banking system is experiencing very low levels or increases in nonperforming loan ratios, but a less favourable macroeconomic backdrop and more prolonged tight financial conditions will likely lead to a deterioration in asset quality. Nevertheless, the Swedish banking system's healthy capitalisation and liquidity buffers and its historically sound credit underwriting standards are reassuring.

Furthermore, recent macroprudential measures, including the rise in the counter-cyclical capital buffer to 2% from 0% and higher risk weight floors on bank exposures to residential and CRE mitigate financial stability risks. However, the Swedish banking system is relatively large, concentrated, interconnected, and reliant on wholesale and foreign funding, rendering it susceptible to potential shocks, including changes in investor sentiment.

Sweden's Strong Competitiveness and High Savings Will Help the Country to Maintain a Strong External Position Despite Weaker External Demand

Morningstar DBRS assesses Sweden's external position as strong and backed by a long period of large current account surpluses, which helped improve the net international investment position (NIIP). Underpinned by the private sectors' high savings rate and Swedish firms' solid competitiveness, the current account has averaged 5.2% of GDP over the past two decades. This, along with a shift to a positive net investment portfolio position, has contributed to a steady improvement in the NIIP, which stood at 45.0% of GDP at the end of Q1 2024. Heightened geopolitical risks, and recent appreciation of the Swedish Krona will not significantly affect Sweden's export performance in the near term, reflecting a favourable and supportive high savings rate and strong external competitiveness. According to the National Institute of Economic Research (NIER), the surplus in the current account should average at above 6.7% of GDP in the 2024-2025 period.

Sweden's small, open, and financially and commercially integrated economy remains exposed to potential swings in investor confidence, financial conditions, or global demand. Nevertheless, Sweden's liquid currency, in the context of a flexible exchange rate mechanism, and total official reserves amounting to around 11% of GDP as of Q1 2024 enhance the country's ability to absorb negative external shocks. Large external debt rollover risk, comprising banks' covered bonds, is mitigated by banks' ample liquidity position and capital.

Strong and Stable Political Institutions Foster Predictable Macroeconomic Policies

Sweden's political system is characterised by strong democratic institutions as reflected by its very favourable Worldwide Governance indicators. Given Sweden's political fragmentation, the country is accustomed to minority governments that may require the support of parties outside of the government to pass laws, promoting political compromise and consensual policy making, although not without occasional political turmoil. The minority government comprising the Moderate Party, the Christian Democrats, and the Liberals, with the external support of the far-right Sweden Democrats could translate into possible government instability, but broad political consensus behind Sweden's fiscal framework and sound macroeconomic policies will continue to underpin the country's prosperity. Russia's invasion of Ukraine resulted in a historic change in Sweden's defence policy, ending its historical neutrality and leading to its application for NATO membership with the support of a large share of political parties. In Morningstar DBRS' view, this is translating into additional military expenditures but not as significant as to weigh on Sweden's prudent fiscal stance.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Social, Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://dbrs.morningstar.com/research/436079/.

Notes:
All figures are in Swedish krona unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (6 October 2023) https://dbrs.morningstar.com/research/421590. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Ministry of Finance (Key Indicators Forecast - June 2024, 2024 Spring Fiscal Policy Bill and Spring Amending Budget for 2024 - April 2024), Swedish National Debt Office, Sveriges Riksbank (Financial Stability Report 2024:1 - May 2024, Monetary Policy Report, June 2024), Swedish Statistiska Centralbyran (SCB), NIER, European Commission (Spring Forecast, May 2024), Eurostat, Swedish Environmental Protection Agency (Sweden's Climate Act and Climate Policy Framework), The Social Progress Imperative (2024 Social Progress Index), Organisation for Economic Co-operation and Development (OECD), Bank for International Settlements (BIS), International Monetary Fund (IMF), World Bank (WB), Macrobond, and Haver Analytics. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

Morningstar DBRS does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/436080/.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Carlo Capuano, Senior Vice President, Sector Lead, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: 17 April 2012
Last Rating Date: 12 January 2024

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